The exploration and production (E&P) sector is going especially strong now, on high commodity prices and debt repayment, but operational performance, corporate governance and accounting issues remain a concern, underscored by the recent negative reserve revisions at Royal Dutch/Shell Group, El Paso Corp. and Forest Oil Corp., according to a report by Standard & Poor’s Ratings Service.
“Although these incidents so far appear to be relatively isolated,” S&P said it “is concerned that more companies could report negative revisions, as the Securities and Exchange Commission (SEC) appears to be reinvigorated, reserve revisions have become particularly newsworthy, many companies re struggling to replace their reserves from internal means and external reserve engineers are likely to be more rigid in their analysis.”
S&P’s analysis concluded that many E&Ps made strong efforts to reduce debt leverage and improve their financial positions in the first quarter of this year. However, many now have been challenged to scrutinize the value and classification of their reserve bases. Two companies have been placed on CreditWatch with negative implications following announcements of negative revisions, including Shell, for its 20%-plus revisions and Forest Oil, which wrote down more than 28% of its 2002 proved reserves. El Paso’s rating already had been lowered.
“With much of the E&P sector benefiting from near- or record-hydrocarbon prices, cash flows have ben above most expectations, allowing significant repayments of bank debt and other maturing or callable debt.” Now, with no debt to repay and many exploration portfolios “thin,” S&P concluded that merger and acquisition activity “will likely increase during the remainder of 2004.”
For the near term, S&P analysts believe oil and natural gas prices “seem likely to hold most of their strength.” At the time of the report, gas was near $5.50/Mcf and oil was above $35/bbl. “Increased levels of gas-fired power generation appear to be offsetting otherwise bearish March heating demand, and could continue to support natural gas prices through the summer heating season…Of course, the weather, developments in Iraq or other intangibles could play on the markets in the near term.”
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